In both euphoric and bear markets, there are stocks that trade at valuations which defy logic. To a large extent, this seems to be the case with AT&T (NYSE:T) stock.
In the last 12-months, T stock has declined by 12.5%. The stock, which has a high dividend yield, currently trades at a forward price-earnings-ratio of 7.2. Meanwhile, the S&P 500 index has a cyclically adjusted P/E ratio of 38.3.
Clearly, T stock looks significantly undervalued. Its downside risk is limited at its current levels, and the shares can climb by a meaningful amount.
It’s true that the decision making of AT&T’s management has been disappointing. And the company’s high debt is a key reason for the stock’s depressed valuation.
However, I believe that the sentiment toward the stock is likely to change once the company’s spin off of Warner Media is completed.
In September 2021, the company’s CEO John Stankey was quoted saying that “he is not satisfied with his own company’s brand.” After the divestment of Warner Media is completed, Stankey plans to change the image of AT&T’s wireless carrier business. At the same time, he will continue to reduce its debt.
Consequently, I am bullish on the 2022 outlook of T stock, and I believe that the stock can outperform the market next year. Let’s take a deeper look into the positive catalysts of T stock.
The Growth of AT&T’s Communications Business
Once the spin off of Warner Media is completed by mid-2022, AT&T will be well- positioned to focus on its communications segment.
In the last five years, AT&T has invested more than $105 billion in its wireless and wireline network. The company’s big investments seems to be over and it should deliver robust free cash flows in the coming years . Once the company’s 5G business accelerates, its margins should also rebound.
Reports suggest that the company’s “network is one of the fastest overall thanks to its excellent LTE network speeds.” Furthermore, “it’s quickly catching up to T-Mobile with its sub-6 5G.”
It’s worth noting that AT&T’s post-paid phone subscribers have been trending higher in the last few quarters. The number of subscribers to the conglomerate’s fiber network has also risen in the last few quarters. Once the spinoff is completed and the re-branding is established, the network’s subscriber growth is likely to accelerate.
Another point worth mentioning is that for Q3, the company reported that its communications segment had generated revenue of $28.2 billion. For the same period, the segment’s EBITDA came in at $11.2 billion. Those numbers indicate that the unit’s Q3 EBITDA margin was 39.7%.
On the other hand, Warner Media reported $8.4 billion in revenue and $2.2 billion in EBITDA. The segment therefore reported an EBITDA margin of 26.2%.
So the communications unit has a healthy EBITDA margin. Once the business gains further traction, AT&T will probably be able to reduce its debt and increase its dividends.
The Bottom Line
The merger between WarnerMedia and Discovery (NASDAQ:DISCA) is likely to create long-term value for the owners of T stock.
It’s worth noting that Discovery already has a presence in 200 countries . The merger will therefore boost the addressable market of HBO and HBO Max.
Currently, the subscribers of HBO and HBO Max have been in an uptrend. As of Q3, they had a combined total of 69.4 million subscribers. However, 65% of their subscribers were from the U. S. The merger will help diversify AT&T’s customer base geographically.
To put things into perspective, Discovery CEO David Zaslav expects the combined entity to have more than 400 million subscribers in the coming years. I believe that even if 60% to 70% of this target is achieved in the next few years, the merged entity is well-positioned to create value for the owners of T stock.
Debt remains a concern for AT&T. However, the company has shown that it can deliver robust free cash flows.
After the company invested significantly in its communications segment in the last few years, its focus is likely to be on cutting its debt and raising its dividends. As a result, T stock looks attractive at its current levels.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.